In this article, we will be looking at the personal finance side of car loans in Malaysia. I recently financed the purchase of my car and did some short calculations. Asked myself questions such as:
- Should I be paying 100% cash?
- When to take a longer-term loan and when to opt for a shorter one?
- TLDR – We want to positive carry the loan.
Contents
How to Look at Car Loans in Malaysia
Almost all cars are depreciating assets. When purchasing a car in Malaysia, many people rely on car loans to help finance the vehicle. While car loans are a common solution for vehicle financing, understanding the terms and conditions of the loan is essential to making a sound financial decision. In this article, we’ll explore the key aspects of car loans in Malaysia and discuss how to approach them intelligently.
Understanding Car Loans in Malaysia
Car loans in Malaysia are generally offered by banks and other financial institutions, with terms that range from 5 to 9 years. The interest rates vary depending on factors like the length of the loan, the borrower’s creditworthiness, and the car’s value. While car loans may seem like an easy way to own a car, understanding the long-term financial impact is crucial.
Loan Tenure
The Pros and Cons of Long Loan Tenures
A significant consideration when taking out a car loan is the loan tenure. Many borrowers opt for longer tenures because they offer lower monthly payments, which can make the loan more affordable on a month-to-month basis. However, longer loan terms come with their drawbacks. One of the major downsides is the higher total interest paid over the course of the loan. While the monthly repayments may seem manageable, borrowers often end up paying far more in interest compared to a shorter loan term. Moreover, cars lose value quickly, and with a long loan tenure, the vehicle may depreciate faster than the borrower can pay off the loan, leaving them owing more than the car is worth.
The Advantages of Shorter Loan Terms
On the other hand, shorter loan terms, typically ranging from 5 to 6 years, come with higher monthly repayments but offer significant advantages. With a shorter loan term, you’ll pay off the loan more quickly and incur less interest overall. This is financially advantageous in the long run, as the total cost of the loan is reduced. Additionally, because you’ll owe less on the car as it depreciates, you’re less likely to be “upside down” on the loan—owing more than the car is worth. However, the trade-off is that monthly repayments are higher, which may put a strain on your cash flow.
How to Choose the Right Loan Term
When deciding between a longer or shorter loan term, it’s important to assess your personal financial situation. If you can afford the higher monthly repayments, a shorter loan term is usually the more cost-effective option. It helps reduce the total interest paid and allows you to build equity in the vehicle more quickly. However, if you’re on a tight budget and need to keep your monthly payments low, a longer loan term may be a better fit, even though it will ultimately cost you more in interest.
Why Stretching Your Loan Tenure Is Bad Advice
You may have heard someone say this, “You should always take the maximum loan term because your instalment for 9 years is going to be lower than your 5-year instalment, you will have more cash flow.”
Some people may suggest that stretching your car loan to the longest possible tenure—such as nine years—is a good financial move because the monthly instalment is lower compared to a shorter loan tenure. They argue that this provides more cash flow flexibility, and if you have extra money, you can always pay more or even settle the loan early. While this may sound logical on the surface, it’s actually bad financial advice.
Yes, increasing your loan tenure will result in lower monthly instalments, but good financial planning isn’t just about minimizing your short-term expenses. A crucial factor to consider is the total interest paid over the life of the loan. The longer your loan tenure, the more interest you will pay, making the overall cost of your car significantly higher.
Another misconception is that making extra payments will help you save on interest or shorten your loan term. However, the way car loans in Malaysia are structured—especially with the Rule of 78—means that early payments do not proportionally reduce your interest burden. Under this system, the bank front-loads the interest, meaning you pay a larger portion of interest in the earlier years of your loan. If you decide to settle your loan early, say after two years on a five-year tenure, your savings from the remaining interest will be far lower than expected because you’ve already paid most of the interest upfront.
Yes, early settlement does save you some money, but the savings are not as significant as many assume. Banks are not charities—they structure loans to maximize their profits. Your goal in financial planning should be to minimize how much banks earn from you and maximize your own savings.
At the end of the day, the best approach is to avoid unnecessarily long loan tenures and instead choose a term that balances affordability with minimizing interest costs. Being mindful of the total cost of borrowing—not just the monthly instalment—is key to making a smart financial decision.
Positive Carry – The Best Way to Look at a Car Loan
The ONLY time you should maximise the tenure of your car loan is when you have the loan amount in cash already. Ie. you’re able to afford to buy the car 100% cash.
Car loans in Malaysia are relatively low, effective interest rates could be 5+% for new cars. And if you put that cash into FDs (3-4% return) or even into REITs (5-6% return), you’ll be earning a positive return.
For example, let’s say your car loan’s effective interest rate is 5% and you invested your money in REITs for a 5.5% return. This gives you a positive carry of 0.5%. Effectively, you’re getting a free loan AND a return of 0.5% for driving the car. In all other cases, you do not want to increase and maximise the tenure of your loan.
Now, I do understand that not everyone would have the ability and capacity to have that much cash lying around. I’m just saying that positive carry is the best possible way of taking a car loan.
Side Note: What is Effective Interest Rate
Car Loan Effective Interest Rate (EIR)
Car loans in Malaysia typically use a flat interest rate system, which may seem low at first glance (e.g., 2.5% to 3.5% per annum). However, the actual cost of borrowing is much higher due to how interest is calculated. The Effective Interest Rate (EIR) is the true cost of borrowing, taking into account the fact that loan repayments reduce the principal over time.
For example, a flat rate of 3% per annum on a 7-year car loan actually results in an EIR of around 5.5% – 6.5%, depending on the tenure. This means that while the flat rate looks low, the real cost of the loan is much higher when considering how interest is spread out.
Additionally, Malaysian car loans often follow the Rule of 78, meaning that most of the interest is front-loaded in the early years. This makes early settlement less beneficial than expected because much of the interest has already been paid upfront.
Conclusion
In conclusion, taking out a car loan in Malaysia is a significant financial decision that requires careful consideration. It’s important to strike a balance between affordable monthly repayments and minimizing the total interest paid over the life of the loan. By assessing your financial situation, comparing loan offers, and understanding the full cost of the loan, you can make a smart decision that benefits you in the long run.
You’ll want to take a look at articles on car loans from both Carro and Carsome. They lay out additional tips that I decided not to cover here as we’re looking at the personal finance side of it.